To stem rapid trading in their funds, mutual fund companies are adding redemption fees that 401(k) plan providers now have to keep track of and communicate to employees.

Just when employers thought the mutual fund scandals were behind them, there is now a new issue they must face. For the past several months, 401(k) plan providers have been reviewing their fund lineups and weeding out offerings managed by fund companies named in regulators’ investigations as being the culprits who allowed rapid or late trading, one of the main findings in New York Attorney General Eliot Spitzer’s investigation

But now it seems that those fund providers not named in the scandals also are causing a headache for employers.

To stem rapid trading in their funds, mutual fund companies are adding redemption fees, which kick in when an investor goes in and out of a fund within a short period of time--usually 90 days.

While this may seem like a good idea in theory, 401(k) plan providers now have to keep track of all the different redemption fee policies each fund company has for each fund in their plans and communicate that to employees.

In some cases, such as with Fidelity Investments, employees could get hit with fees for automatic rebalancing or for withdrawing funds due to a hardship--a point that has already caused the Coca-Cola Co. to drop the firm from its plan, a company spokeswoman says. Other companies also are considering moves because of the fee issue.

If that were not enough, many predict that an increase in record-keeping costs is inevitable since there is so much more to keep track of with these policies in place. "A company has to program its system for all of these different rules, and it’s expensive," says Martha Tejera, consultant and principal at Mercer Human Resource Consulting. "It’s a pain in the neck."

Rapid trading of mutual funds, also known as market timing, refers to the practice of traders jumping in and out of funds in an attempt to take advantage of inefficiency in pricing.

This kind of activity causes an increase in trading expenses for the fund, which ends up costing long-term shareholders. When Spitzer’s investigation discovered in 2003 that these practices were taking place, the Securities and Exchange Commission said it would mandate 2 percent redemption fees, but the proposal has yet to become a rule.

To be proactive, many fund companies have started implementing their own fees, each with their own sets of terms.

Firms that provide record-keeping services, which include Fidelity and T. Rowe Price as well as a number of technology companies, have spent the past few months hustling to create systems to keep track of all of the different funds’ redemption policies.

"What this is going to mean for employers is increased costs, even if their participants are not doing short-term trades, because all of the record-keepers are going to have to track all of the trading going on," says David Wray, president of the 401(k) Profit Sharing Council of America, a nonprofit association representing 1,200 employers.

According to a recent council survey, 86.2 percent of its members with 5,000 participants or more offer 401(k) plans with more than one fund family and thus will have to bear these added costs.

Record-keepers and consultants would not predict what the increase in costs could be because the operations have yet to fully be put in place.

But Michael Rice, manager of third-party administrator services at Fiserv Trust Services, a custodian, notes that he has heard record-keepers say that they might add trading fees on top of the redemption fees, while others have just talked generally about increasing costs.

"Nobody knows what the magnitude of this will be," he says. Some, however, say that as long as the stock market continues to improve and 401(k) account balances are on the rise, record-keepers shouldn’t have to raise fees.

"When it’s something that affects the whole industry, there is certainly a possibility to raise costs. But on a practical matter, I don’t think they will," says Michael Weddell, a consultant at Watson Wyatt. In general, record-keepers’ revenue depends on the assets within the plan.

Informing employees Many employers are struggling with the right way to communicate the various redemption fee policies to employees. This is no easy feat, particularly when each fund could have a different fee and varying conditions on when it should be applied, Wray says.

For example, Fidelity’s redemption fees range from 0.25 percent to 2 percent and cover trades made within 30 to 90 days, depending on the fund, while T. Rowe Price’s fees range from 0.5 percent to 2 percent with a 90-day maximum.

To help employers, some record-keepers, such as Fidelity and T. Rowe Price, are offering software that alerts employees when they are about to make a trade that would prompt a redemption fee. Call center representatives are also provided with this software for trades made over the phone. Such notification systems are important particularly because employees may not read or understand a one-time communication.

While redemption fee information is in the funds’ prospectuses, employees don’t always read them, says Gene Rubenstein, vice president at Fidelity. "Having a proactive system in place that notifies participants at the time of the transaction really helps," he says.

Fidelity, which has had redemption fees for the past 10 years, offers this system, but some record-keepers that are still getting a handle on redemption fees have yet to develop these capabilities, Rubenstein says.

Even those employers that do have these systems in place are still being careful to take every opportunity to mention the redemption fees in communications with employees.

"With everything you send out, you need to think about whether you need to address a redemption fee issue," says Richard Menson, an employee benefits attorney in the Chicago office of McGuire Woods who also oversees the law firm’s 401(k) plan.

Fairness issue As employers review the funds in their plans, they also will have to consider whether the fund companies’ redemption policies are fair to employees.

Most fund companies are using discretion with their redemption fees in 401(k) plans and are applying them only when an employee actively makes a short-term exchange.

But Fidelity has raised some controversy by applying its fees to all trades, which may include hardship withdrawals and automatic rebalancing, in which an employee’s 401(k) investments will be reconfigured on a periodic basis, usually quarterly, to fit his or her predetermined asset allocation.

When employees sign up for 401(k)s they answer a number of questions, such as their age and risk tolerance, which determines what their asset allocation should be. "My concern is that some providers are imposing the fees on activities that, in my view, aren’t egregious," Mercer’s Tejera says. And, she notes, "what’s happening is that quietly and slowly some clients are pulling out of these funds."

In a not-so-quiet move, Coca-Cola’s retirement plan, which had $9 million of its $1.3 billion invested in Fidelity’s Advisor Diversified International Fund, closed the fund to new investments last year and replaced it with Thornburg Investment Management’s International Value Fund. "Primarily it’s because of the redemption fees," says Raquel White, a Coca-Cola spokeswoman.

David Jones, senior vice president at Fidelity, says that the firm believes its policy should be consistent for all circumstances and has no plans to change it.

In reality, he says, these fees will apply to few employees because when an employee sells shares through rebalancing, Fidelity first sells the shares held the longest. "Our experience is that with automatic rebalancing, the fee rarely happens," he says.

The firm has agreed to waive the fee for hardships and loans for some record-keepers that do not yet have their systems in place to meet its deadline for compliance, which originally was Dec. 31 but now is March 31.

Jones emphasizes that for now Fidelity itself is paying the fees back into the fund, but he could not say how long the firm would continue to do this.

Vin Loporchio, a Fidelity spokes-man, says the firm paid millions of dollars back to the fund last year, but declined to provide an exact figure. Still, most employers are keeping an eye on these fees, particularly as they add new funds to their plans, consultants say.

"This is now another issue that I will look at when I look at a fund," Menson says.